Discover 2015 Annual Report Download - page 162

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Other Long-Term Borrowings
Fair values of other long-term borrowings, consisting of subordinated and senior debt, are determined utilizing
current observable market prices for those transactions and, as such, are classified as Level 2. A portion of the
difference between the carrying value and the fair value of other long-term borrowings relates to the cash premiums
paid in connection with the 2012 fiscal year debt exchanges. The fair values of other long-term borrowings classified as
Level 3 consist of capital leases.
Accrued Interest Payables
The carrying value of accrued interest payables, which is included in accrued expenses and other liabilities on
the consolidated statements of financial condition, approximates fair value as it is payable in less than one year.
22. Derivatives and Hedging Activities
The Company uses derivatives to manage its exposure to various financial risks. The Company does not enter
into derivatives for trading or speculative purposes. Certain derivatives used to manage the Company’s exposure to
interest rate movements and other identified risks are not designated as hedges and do not qualify for hedge
accounting.
Derivatives may give rise to counterparty credit risk, which generally is addressed through collateral
arrangements as described under the sub-heading "— Collateral Requirements and Credit-Risk Related Contingency
Features." The Company enters into derivative transactions with established dealers that meet minimum credit criteria
established by the Company. All counterparties must be pre-approved prior to engaging in any transaction with the
Company. Counterparties are monitored on a regular basis by the Company to ensure compliance with the Company’s
risk policies and limits. In determining the counterparty credit risk valuation adjustment for the fair values of derivatives,
the Company considers collateral and legally enforceable master netting agreements that mitigate credit exposure to
related counterparties.
All derivatives are recorded in other assets at their gross positive fair values and in accrued expenses and other
liabilities at their gross negative fair values. See Note 21: Fair Value Measurements and Disclosures for a description of
the valuation methodologies of derivatives. Cash collateral posted and held balances are recorded in other assets and
deposits, respectively, in the consolidated statements of financial condition. Collateral amounts recorded in the
consolidated statements of financial condition are based on the net collateral posted or held position for each
applicable legal entity's master netting arrangement with each counterparty.
Derivatives Designated as Hedges
Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows
arising from changes in interest rates, or other types of forecasted transactions, are considered cash flow hedges.
Derivatives designated and qualifying as a hedge of the exposure to fluctuations in foreign exchange rates on
investments in foreign entities are referred to as net investment hedges. Derivatives designated and qualifying as a
hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular
risk, such as interest rate risk, are considered fair value hedges.
Cash Flow Hedges
The Company uses interest rate swaps to manage its exposure to changes in interest rates related to future cash
flows resulting from interest payments on credit card securitized debt and deposits, and previously from interest receipts
on credit card loan receivables. The Company's outstanding cash flow hedges are for an initial maximum period of five
years for securitized debt and seven years for deposits. The derivatives are designated as hedges of the risk of changes
in cash flows on the Company’s LIBOR or Federal Funds rate-based interest payments, and qualify for hedge
accounting in accordance with ASC Topic 815, Derivatives and Hedging (“ASC 815”).
The effective portion of the change in the fair value of derivatives designated as cash flow hedges is recorded in
OCI and is subsequently reclassified into earnings in the period that the hedged forecasted cash flows affect earnings.
The ineffective portion of the change in fair value of the derivative, if any, is recognized directly in earnings. Amounts
reported in AOCI related to derivatives at December 31, 2015 will be reclassified to interest expense as interest
payments are made on certain of the Company's floating-rate securitized debt or deposits. During the next 12 months,
the Company estimates it will reclassify $26 million of pretax losses to interest expense related to its derivatives
designated as cash flow hedges.